What Trump and Brexit Have in Common

What Trump and Brexit Have in Common

One can only agree that 2016 took a different path than expected. In November 2016, US citizens cast their vote in the presidential elections. Although most polls predicted differently, giving Hillary Clinton on average about 3.2% difference ahead of her opponent, the Republican Donald Trump was elected as the 45th US president.

About five months earlier, the UK unexpectedly voted in favour of withdrawing from the European Union. It is a kind of incident that the European Union is totally unacquainted with.

2016 also showed a significant increase in the support for ‘populist’ parties in many European countries. Right-wing populist parties have been strengthening in the polls, such as Alternative für Deutschland (led by Frauke Petry) in Germany, the Front National (led by Marine Le Pen) in France and Partij Voor de Vrijheid (led by Geert Wilders) in the Netherlands. With elections upcoming in 2017 in these three countries, those parties’ roles will be of major importance.

Although these events may seem unrelated at first, a common factor can be drawn out – that of globalisation.

Globalisation: The Force Driving Populism?

The idea behind this American choice for Trump, a vote against the European Union and the increase in support for right-wing parties is that globalisation has led to an increase in income inequality, which in turn has caused people that are adversely affected by this inequality to show their growing discontent. From the following analysis, it follows that up till now the silent majority has not benefited from international trade – or not as much as the top-income earners did. Now, this group may become increasingly assertive in opposing the current levels of income inequality and, therefore, have felt the appeal of voting against the establishment.

Economic Theory

To get a deeper insight into this anti-establishment vote one should firstly look at what economic theory predicts. Numerous economic models have been designed to describe the effects of increased globalisation on major economic variables. One example is the model of comparative advantages by David Ricardo that concentrates on relative differences in the productivity between countries. It takes the opportunity costs of producing a specific good into account and then determines which good is more efficient to produce. The most well-known models of international trade, the model of absolute advantages (Adam Smith), the model of comparative advantages (David Ricardo) and the Heckscher-Ohlin model, predict that people with

he most well-known models of international trade, the model of absolute advantages (Adam Smith), the model of comparative advantages (David Ricardo) and the Heckscher-Ohlin model, predict that people with labour-intensive, low-skilled jobs in the western world will indeed be adversely affected by increased globalisation.

Those jobs are likely to be off-shored, i.e. they will be moved towards emerging countries where wages and production costs are lower. The low-skilled labour force in these emerging or developing countries, which represents a particularly large fraction of the total labour force in these economies, will benefit from this outsourcing.

In the western world, high-skilled or capital-intensive jobs will typically gain from more trade. Consequently, economic theory predicts that income inequality in the western world will rise over time.

Empirical Observations

In accordance with economic models of international trade, it has indeed been found that low-skilled workers faced substantial declines in their real wages. Moreover, two trends that go hand in hand have emerged in the last 50 years. Wage polarisation, which refers to the gradual increase in wages of low and high-skilled jobs at the expense of middle-skilled ones, led to an increase in income inequality.

This wage polarisation may have its grounds in job polarisation, which entails that especially middle-skilled rather than low-skilled workers are the ones that lose from international trade in terms of job availability. The intuition is that consumer-interactive tasks performed by low-skilled workers, such as haircuts and taxi services, cannot easily be outsourced to other countries.

These activities are location specific. Moreover, routine tasks performed by middle-skilled workers can be split more easily and are, therefore, more prone to offshoring. Job polarisation implies that low and high-skilled jobs have become more attractive, thereby increasing their wages, at the expense of the middle-class.

The Elephant Graph

In 2012, Milanovic calculated the changes in real incomes between 1988 and 2008 in the global income distribution (in 2005 international dollars), finding some overlap with job and wage polarisation. The period under consideration is of special interest as deregulation and market-based reforms took off and, consequently, globalisation as well.

When depicted in a figure, it resulted in the so-called elephant graph (Figure 1, below). It is a clear visual representation of the winners and losers of globalisation. The largest gains of globalisation flow to the middle class of the emerging economies. Large parts of the populations from China, India, Indonesia, Brazil and Egypt are located around this median income, where increases up to 80% have been attained.

The top 1% of the global income distribution, which typically consists of the very rich in the western world, has no reason to complain either as their incomes have increased by about 60%. The bottom one third, apart from the poorest 5%, has also seen significant increases in their real incomes. This might be due to the large reduction in poverty that has been achieved as part of the Millennium Development Goals.

1bn people have were lifted out of poverty from 1990-2000

From the twenty years following 1990, about 1 billion people were lifted out of poverty. A reason why the poorest 5% has not benefited from globalisation could be that those people are really difficult to reach. The provision of aid to them might be impossible or ineffective.

The most relevant part of the elephant curve to the interpretation of why people voted for Trump, for the Brexit and support right-wing populistic parties to a larger degree, is the 75th till 90th percentile.

This global upper class largely consists of citizens in rich countries and former communistic ones. These people have not benefitted at all from the increase in globalisation while so many people not only have but also to a significant extent. This discrepancy resulted in an increase in income inequality in the developed world.

Figure 1. The ‘Elephant Graph’, showing increases in real incomes between 1988 and 2008 for the world population.

(Source: Milanovic (2012), Global Income Inequality by the Numbers: in History and Now)

Gini Coefficient

A different but commonly used and well-known measure of income inequality is the Gini coefficient, which measures the extent to which the distribution of income within an economy deviates from a perfectly equal distribution. It ranges from zero, where everybody earns the same income, to one, where all income goes to a single person.

From an OECD sample, it follows that 17 out of 22 countries faced a substantial increase in their Gini-coefficients between 1985 and 2008, while only 2 countries saw their Gini-coefficients drop. The Gini coefficient in 1985 stood at an average of 0.29, from which it increased by almost 10% to 0.32 in 2008.

Clearly, income inequality in the developed world has been rising since the mid-1980s, which corresponds to the same period in which globalisation took off.

Figure 2. Gini-coefficients of 22 OECD countries (1985 and 2008).

(Source: OECD)

Solution

The losers, or at least non-winners, of globalisation, are the ones that increasingly take a different viewpoint on contemporary developments and show these concerns in the political landscape. Currently, some policy makers and politicians try to address these concerns by falling back on the ideology of protectionism, that generally has seen decreasing support since Adam Smith championed free trade with The Wealth of Nations.

In practice, this tendency is being expressed via cancelling trade agreements (Trump has endangered them by pulling the US out of TPP and probably will do the same for TTIP as well), threatening to raise import tariffs to protect one’s economy, the withdrawal of the United Kingdom from the European common market, and some countries’ threats to step out of the Eurozone.

This change in direction is not only highly unwanted for the very rich in the western world, but for all. When globalisation is reduced, it will lead to a reduction in total welfare. Overall, citizens in developed countries will have less to spend when tariff and non-tariff barriers are reintroduced, when trade routes are closed and when trade agreements are cancelled. Trade makes products available at lower prices and makes people able to export their products.

Deliberately giving up some part of potential welfare is undesirable and, first and foremost, unnecessary. Western governments will have to distribute the gains of international trade more equally among their populations. This implies that the top of the income distribution will face slower increases in their real incomes, that were caused by globalisation than they have been used to.

Conclusion

Governments have many policies at their disposal to solve these issues. One can roughly distinguish two kinds of policies: policies that specifically aim at those negatively affected by international trade and policies that more generally try to reduce income inequality.

The first would be more appropriate but is at the same time more difficult to design. It could involve extra retraining and schooling programs for workers that have likely lost their job because of globalisation, like some blue-collar workers. A policy that reduces income inequality in general, and therefore being less precise, would be a reform of a government’s tax system, for instance by increasing income taxes for the very rich.

Creative and careful analysis of policies will have to be carried out in order to make sure that they address the problem at hand. To conclude, in answering the needs and concerns of an increasing part of the population in the developed world, politicians and policy makers would do best to ignore the tendency to move towards protectionism and instead focus on a better redistribution of the gains of globalisation. It will be a step forward.

Get articles like this straight to your inbox each morning with our Breakfast Briefing. Sign up by clicking here!